The Optimal Structure of Securities under Coordination Frictions

64 Pages Posted: 20 Jun 2023 Last revised: 17 Oct 2023

See all articles by Dan Luo

Dan Luo

The Chinese University of Hong Kong Business School

Ming Yang

UCL

Date Written: October 15, 2023

Abstract

We study multiagent security design in the presence of coordination frictions. A principal implements a project whose value increases with an unknown state and the level of agents’ participation. To motivate agents’ participation, the principal offers them multiple monotone securities backed by the project value. More participation results in a higher project value, making participation decisions strategic complements. Miscoordination arises because agents cannot precisely infer others’ decisions from noisy observations about the state. We identify two objects in security design—“payoff sensitivity” and “perception of participation”—that determine the impact of miscoordination. To mitigate the adverse impact of miscoordination, the two objects should be matched assortatively over agents. This mechanism implies a multitranche structure where senior tranche–holders, who are more robust to miscoordination, participate more aggressively and help alleviate junior tranche–holders’ fear of miscoordination. The principal’s ability to differentiate agents in security format is crucial to whether differentiation is desirable.

Keywords: contracting with externalities, coordination frictions, security design, global games

JEL Classification: D71, D83, D86, G32, L24

Suggested Citation

Luo, Dan and Yang, Ming, The Optimal Structure of Securities under Coordination Frictions (October 15, 2023). Available at SSRN: https://ssrn.com/abstract=4484914

Dan Luo

The Chinese University of Hong Kong Business School ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Shatin, N.T.
Hong Kong

Ming Yang (Contact Author)

UCL ( email )

Drayton House, 30 Gordon Street
30 Gordon Street
London, WC1H 0AX
United Kingdom

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